Choice of payment method and acquirer’s legal origin in M&As: Evidence from five selected leading
emerging countries
Name: Jialun Song ID number: S2293188 Study Program: Msc Finance Master thesis
Thesis advisor: Dr. Lammertjan Dam
Subject: shareholder wealth effects of M&A’s University Of Groningen
I am very grateful for the advices and comments from Lammertjan Dam (University of Groningen).
Dr. Lammertjan Dam gave me many splendid advices on the design, research and writing of the thesis.
I feel more familiar with a researcher’s work through this thesis course. This can be a start point of my
ABSTRACT
Applying event study methodology and multifactor analysis, I focus on 374 completed deals by selecting five leading emerging countries1 (China, India, Brazil, South Africa and Singapore) between 2004 and 2011 to investigate the effects of means of payment and acquirer’s legal origin in the context of M&A deals. My results are a striking departure from previous literature with respect to the stock financed deals in developed markets. My study shows a positive effect of stock financed deals on the acquirer’s shareholder wealth2. My findings are consistent with the work of Alexandridis et al. (2010) who conclude that stock payment method does not necessarily destroy value of the deal in a less competitive market. In order to explain positive effect of stock financed deals, I offer financial constraint hypothesis, investment opportunities hypothesis and risk sharing hypothesis. Furthermore, I also examine the effect of acquirer’s legal origin3 in a similar way. Consequently, I do not find obvious effect of legal origin as a sign of political influence on bidder’s performance in emerging economy. It appears that legal origin fails to explain the difference of the bidder’s performance.
Keywords: Mergers, acquisitions, takeovers, payment method, bidder returns, legal origin, civil law, common law, emerging market, China, India, Brazil, South Africa, Singapore
1See http:dmi.thomsonreuters.com/Content/Files/3Q12_MA_Emerging_Market_Financial_Advisory_Review.pdf
2Shareholder wealth is basically the wealth shareholders get to accrue from their ownership of shares in a firm.
Shareholder wealth increases by the rise in share prices that bring about capital gain. A firm can maximize shareholders' wealth through this way. In a M&A event, the movement in share price influence the shareholder wealth directly.
3Legal origin is divided into two categories: civil law and common law. The common law legal system is mainly the law of England and its former colonies. Appellate judges by solving legal disputes form this law. The civil law legal system originates in Roman law and uses comprehensive codes as its primary ordering legal material formulated and ascertained by legal scholars.
1 INTRODUCTION
Determining the method of payment (cash, stock, or mixed) may be the first step once an acquiring firm’s management feel convinced about the benefits of an acquisition deal. The choice of means of payment affects an acquirer’s financial structure, free cash flow level for future investment opportunities, managerial ownership and risk sharing. Market environment plays a vital role in shaping both the bidder’s behavior and strategic plan. Myers and Majluf (1984) focus on the asymmetric information between the bidder and target on the value of bidder’s shares and state that acquirers will offer shares if their shares are undervalued and offer cash if their shares are overvalued. The market will regard this behavior as a value-destroying process.
Are stock financed deals value-destroying? Do stock financed deals give more benefits to acquirer’s shareholder in comparison to cash financed deals? Does emerging market react differently with respect to the method of payment? Most of the empirical researches on means of payment affecting acquirer’s wealth have largely focused on developed market; the evidence on the emerging market is limited. Moreover, evidences with respect to acquirer’s shareholder wealth effects of choice of payment method are inconclusive (Myers and Majluf, 1984; Martin, 1996; Chatterjee and Kuenzi, 2001; Faccio and Masulis, 2005; Alexandridis et al., 2010; Martynova and Renneboog, 2011).
This paper explores these questions in two steps. Firstly I apply event study methodology to estimate the return effect of a specific event on the stock price of the bidders. After that I perform multivariate analysis to examine the effect of the method of payment on both the acquirer’s abnormal return on the initial announcement date and acquirer’s accumulated abnormal return around the announcement.
This paper also investigates the effect of acquirer’s legal origin in a similar way.
Acquirer’s legal origin can also influence acquirer’s shareholder wealth through unique corporate governance style (more government intervention, lower productivity of SOE firms and less efficient financial market). Rafael et al. (2007) conclude that common law uses social control strategies to support private market outcomes, whereas civil law is concerned with state-desired allocations. Therefore government intervention and national champion4 phenomenon are more common in civil law system than those in common law system. So it is expected that the legal origin such as civil law or common law can work as a factor affecting the bidder’s performance.
The rise of mergers and acquisitions (M&As) in the world over the eight years has been dramatic. Emerging market is playing a more and more important role in this merger wave. Unlike developed markets, emerging markets experience lower market efficiency, higher risk premium, higher risk-adjusted returns, different corporate governance style and culture, each of which has an influence on shaping the acquirer’s behavior. Acquirers in emerging market also show different motives in an M&A deal compared to their developed-market counterparties. Acquirers in emerging market aim to gain access to production and new technology and to maximize their advantages over their local competitors whereas acquirers in developed market tend to pursuit synergy gain. The under-developed debt funding market of emerging countries also adds motives for acquirers to choose stock as method of payment in M&A deals.
It is hard for bidding firms in emerging market to find debt funding. The less developed financial market pushes the stock payment more favored by bidders.
In this study, I focus on 374 completed deals by selecting five leading emerging countries (China, India, Brazil, South Africa and Singapore) between 2004 and 2011 to investigate the effects of means of payment and acquirer’s legal origin in the context of M&A deals. My results are a striking departure from previous literature
4National champion is a political concept in which large corporations in strategic sectors are expected not only to seek profit but also to "advance the interests of the nation.‖ See http://en.wikipedia.org/wiki/National_champions
with respect to the stock financed deals in developed markets. My study shows a positive effect of stock financed deals on the acquirer’s shareholder wealth.
My principle findings are consistent with the work of Alexandridis et al., 2010.
Alexandridis et al., 2010 conclude that stock financed deals do not necessarily destroy the value of the deals in a less competitive market. In order to explain the positive effect of stock financed deals, I offer financial constraint hypothesis, investment opportunities hypothesis and risk sharing hypothesis. I also examine the effect of acquirer’s legal origin in a similar way. I do not find any obvious effect of legal origin as a sign of political influence on bidder’s performance in emerging economy. It appears that legal origin fails to explain the difference of the bidder’s performance.
My study contributes to the literature in two different ways. First, I organize the sample in a global view which consists of five leading emerging markets. I take the view that different size of the economy and the maturity difference of capital market will lead to different results. Second, I use legal origin as a representative of political factor to explore how political environment can influence the acquirer’s wealth. There is very limited literature which test legal origin in this way. Most of them mainly focus on a cross-border legal origin difference5 between the bidder and the target. In emerging markets, I believe that political factor6 plays a vital role in influencing legal regulation and market behavior in emerging market.
The remainder of my paper proceeds as follows, Section 2 illustrates the literature review of emerging market, payment choice and legal origin. Section 3 and 4 shows the methodology and data selection. Section 5 discusses the empirical results and robustness test. Section 6 presents summary and conclusions.
5The bidder and the target are in different legal system in cross-border deals. A stronger legal system can protect firms more. The difference of legal protection level can work as a factor in determining the performance of acquiring firm.
6Dinc and Gupta (2011) argue that political and law issues matter in privatization, which have positive effects on acquiring firm performance.
2 LITERATURE REVIEW
I conduct the literature review in three parts: First, I list the main difference between emerging market and developed market which can exert an influence on business strategies. Second, I organize the literature with respect to the choice of payment in M&A deals. The literature on the choice of payment in M&A deals has branched out in the form of different theories based on asymmetric information, investing opportunities, risk sharing, managerial ownership, tax effects and budget constraints.
Finally, I also organize the literature review with respect to legal origin and build connections between acquirer’s legal origin and political issues.
2.1 Emerging market vs. developed market
Overall, there are two main differences between emerging market and developed market which matter in determining acquirer’s behavior.
The first one is associated with market efficiency and risk premium. Compared to developed countries, emerging countries tend to develop moderate equity markets with functionally imperfect efficiency. According to the work of Bekaert et al., 1998;
Susmel, 2001, emerging market has highly non-normal and high volatile returns and short samples. Bekaert and Harvey (2003) state that emerging markets are not as efficient as developed markets in transforming information and the liberalization process in emerging market has result only a very small upside in correlation with the whole world market. Moreover, according to Hoque et al., 2007, share price in most Asian counties do not experience a random walk. Lagoarde-Segot and Lucey (2008) also find differences in stock market size and corporate governance factor can explain the weak-form efficiency in the MENA7 stock market. The empirical evidence on the market efficiency in emerging markets has outlined several factors that hinder the
7MENA means ―Middle East and North Africa‖
flow of information in emerging stock market: political and economic uncertainties;
low level of competition; non-transparency of basic information with gradual, structural break data; poor regulation, weak auditing experience; illiquidity of information impeding the market’s capacity to meet orders; and slow reaction to new information due to incompletely developed culture of equity. These characteristics of emerging markets raise the investment risks and it is a common sense that the portion of risk that is not covered by diversification should be compensated by external risk premium. Berrill and Kearney (2011) compare the monthly market returns between developed countries and emerging markets and illustrate that emerging market experience higher return and higher volatilities. Except for that, emerging market clearly has ex-post outperformance over the developed countries. Salomonsa and Grootveldb (2003) also find that emerging markets produce higher equity risk premium than developed markets and this reward varies through time.
Corporate governance also matters in shaping firm’s behavior in three directions:
government quality, state ownership and financial market development. It is hard to say which factor is fundamental and which is secondary. Most of them are related.
Emerging markets have a common feature of severe government intervention on trade through taxation, regulation and state ownership. Shleifer and Vishny (1994) conclude that government policy has a significant effect on the emerging markets business activities. Connection building is an important behavior distortion under the low quality government due to the bureaucrats and politicians’ self-interests. Fishman (2001) finds political connection as an important role in Indonesian firms. Firm managers may build connections with politicians who can give them business privileges like loans of state banks (Khawaja & Mian, 2005). As a result, the more corrupt countries with weaker laws firms in, firms have more debt in their capital structure (Fan et al., 2012). Firms in emerging markets with poorer quality of government will have more complex structures, weaker corporate governance and poorer transparency （ Leuz & Oberholzer-Gee, 2006; Jiang et al., 2010 ） .
Stated owned firms (SOEs) transferred to private sectors cannot be free due to government intervention in emerging market. Shleifer (1998) finds that the politicians’
interfering state owned firms to transfer wealth can explain the low productivity of SOEs. Government can send bureaucrats to SOEs as directors to support economy and execute the policies. As a consequence, the SOEs in emerging markets may show different results due to the incentive and interference of government compared to firms in a private sector.
There are several factors or reasons that explain the weakness of financial market in many emerging markets: (1) poor allocation due to government interference. For example, Allen et al., 2005 find that big-four state banks show their reluctance to lend loans to private sector but state-owned firms. (2) The weakness of legal systems in protecting investor’s rights also hampers the development of financial markets. All these weak oversight and poor protection raise the cost of equity capital in emerging markets. Chen et al., 2009 conclude that corporate governance effect is stronger in poor legal protection countries. (3) Firms in emerging markets find hard to get access to external capital, debt or equity. Building connection with the politicians imposes the non-price mechanisms. All these restrictions on the financial market in emerging markets can influence the pattern or behavior of business activities.
2.2 Cash vs. stock offer
The literature on the choice of payment in M&A deals has branched out in the form of different theories, which embrace contradicted predictions.
Myers and Majluf (1984) initiate the asymmetric information hypothesis by arguing that the bidder will be more willing to offer shares if its stock is overvalued and to offer cash if its stock is undervalued. Therefore, a cash offer may show a positive signal to the market. A share offer may indicate that it is a value destroying deal
because the share is overvalued. As a result, cash offer is more favored than stock offer. The asymmetric information theory is confirmed and extended by a number of empirical studies. Hansen (1987) apply a bargaining model under asymmetric information stating that when the target know more about its value than the bidder, the bidder will be more willing to offer stock and find that financing method is related to the relative size of the target and bidder involved. Fishman (1989) argues that the acquirer would offer cash to avoid competitive bids, implying a higher valuation of the target. Shleifer and Vishny (2003) confirm the theory and concluded that the bidder has a strong incentive to increase its stock price. Then it can make acquisitions with stock. More overvalued stock make the firms survive and grow, but less overvalued stock may make the firm become the acquisition target. This benefit even imposes an incentive for the firm to raise its stock price through earning manipulation (D’Avolio et al., 2001).
Contradicting the prediction of asymmetric information hypothesis, investment opportunity hypothesis apply growth opportunities to explain the method of payments in M&As. Myers (1977) argues that a firm with better future investment opportunities will choose to issue less debt to preserve the cash flow. Martin (1996) tests and confirms investment opportunity hypothesis by concluding that bidders with excellent future investment opportunities are more willing to offer shares for acquisitions than those with poor investment opportunities. The study by Jung et al., 1996 also find similar result. Risk sharing hypothesis also show its preference to stock offer by stating that if the firm’s manager find hard to manage the risk of a transaction, the firm will be more likely to offer stock rather than cash to share the responsibility of realizing synergies, resulting a gain to both sides ( Chatterjee & Kuenzi, 2001).
Alexandridis et al., 2010, using a global database, also find evidence that stock offer does not always destroy value in less competitive markets. The negative effect of share offer may be covered by the synergy effect of acquisitions. Ahmad and Andreas’
study in 2010 find weak evidence for asymmetric information or budget constraints
and concluded that synergy effect in M&As should receive more attention and this omission may show many surprising results.
There is another set of models developed based on taxation argument in a cost perspective. Fuller, Netter and Stegemoller in 2002 argue that the higher cost of immediate taxability of cash offers will make bidders and targets tend to stock offer which are taxable only when disposed-off. Harris, Franks, and Mayer (1987), and Huang and Walking (1987) confirm the importance of taxation as a determinant of choice of payment method in acquisitions.
Managerial ownership also attracts some attentions in determining method of payment in acquisitions. Stock financed deals may impose higher risk of diluting existing shareholder’s stake and hence making them losing control over the company. The empirical studies show evidence to support this theory (Amihud et al, 1990;
Blackburn et al, 1997;Swieringa & Schauten 2007).
The financial constraint hypothesis states that stock offer will be favored by financially constrained acquirers as they can save more resources in acquisition process to protect firm against future uncertainty and remain flexible. Alshwer et al.
2011 use a sample of financial constrained firm and find a positive effect of stock offer on bidder’s stock valuation.
Faccio and Masulis (2005) focus on a trade-off theory between managerial ownership and financial constraint. They conclude that bidders with more concentrated ownership will prefer cash offer to maintain its control of the firm and bidders with severe financial constraints problem will be more likely to choose stock offer.
To sum up, empirical studies on the choice of payment method in M&A deals are inconclusive. An interesting study by Martynova and Renneboog (2011) report that
the valuation of an acquisition paid in cash but financed by debt is similar to that only with equity.
2.4 Legal origin difference matter under the influence of corporate governance in emerging market in shaping the acquirer’s business behavior
There are two main legal origins throughout the world: civil law and common law.
The common law legal system is mainly the law of England and its former colonies.
Appellate judges by solving legal disputes form this law. The civil law legal system originates in Roman law and uses comprehensive codes as its primary ordering legal material formulated and ascertained by legal scholars. As noted by Zweigert and Kotz (1998), the different style between civil law and common law manifests itself in organizing the economic and social life.
Legal origins are strongly associated with many spheres of regulation and law-making.
A number of legal rules like investor protection and legal procedure can protect outside investors and then the financial markets. Rafael et al. (2007) conclude that common law use social control strategies to support private market outcomes, whereas civil law is concerned with state-desired allocations. The phenomenon of
―national champion‖ which means that large corporations aim not only to seek profit but also to advance the interests of the nation is more common in civil law system than in common law. The legal status and political factors are proved to have influence on the return to investors in acquiring firms. Boehmer et al., 2005 find evidence of political factors in banking sectors. Dinc and Gupta (2011) argue that political and law issues matter in privatization, which have positive effects on acquiring firm performance. Recently, Borisova et al., 2012 compare the level of firm’s corporate governance with and without state ownership in two legal origins and found that SOE firms in civil law system experience worse corporate governance.
LaPorta et al., 1997 conclude that acquiring firm in common legal system can benefit from finding cheaper capital to make post-acquisition investment, which leads to
greater deal value. Countries in common law system also has some institutional differences: lower market return, lower growth rate, higher market capitalization, greater financial market development, more protection on properties and more decentralized regulation (King & Levine, 1993; Paul & Mahoney, 2000; Glaeser &
Shleifer, 2002; Buchanan & English, 2007).
3 METHODOLOGY AND HYPOTHESIS DEVELOPMENT
To investigate how the method of payment and acquirer’s legal origin affect acquirer shareholder’s wealth, I perform an event study framework and multivariate analysis.
An event study aims to use acquirer’s stock price reaction as an estimation of the return impact of an acquiring behavior. A multivariate analysis then takes into account the effects of different characteristics of deal on the response of the performance of the bidder.
3.1 Event study framework
The objective of the event study framework in M&A research is to estimate the return impact of a specific event on the stock prices of bidders and targets. Instantly the information of an event is dispersed, new market knowledge may become available and alter the market’s expectations about the future performance of the bidder.
MacKinlay (1997) concludes that the estimation of an event’s impact on economic performance can be measured by stock price movement in short-term relative to productivity measure in the long run. Therefore, I use the stock price movement of the acquiring firm as the performance of the bidder in this paper. An upward movement in stock price means positive benefits to shareholder of the bidder, while a downward movement means that the bidder suffer losses.
3.2 Market model and abnormal return
Applying Brown and Warner’s (1985) standard event study methodology8, I compute abnormal returns (ARs) and cumulative abnormal returns (CARs) in different event windows (-2, 2), (-10, 10) and (-40, 40) around initial acquisition announcements.
A linear relationship is assumed in the market model between the return of securities such as the stock price and the return of the market portfolio.
Rjt = αj + βjRmt + εjt (1)
Where:
Rjt : Daily return of acquirer’s stock price at time t (calculated Pt/Pt-1-1) Rmt : Market returnat time t (calculated Pt/Pt-1-1)
α : Model’s intercept estimated β : Historical estimated slope
Pt and Pt-1 are the stock price at time t and t-1
To estimate the different event window coefficient, I use the MSCI indices system as market return for five leading emerging countries (MSCI China index, MSCI India index, MSCI South Africa index, MSCI Brazil index and MSCI Singapore index).
MSCI Inc. presents a leading provider of investment strategy tools for institutional investment. It provides appropriate market portfolio to tracking the market movement.
.
To predict stock price effects, I use the event date as the focal point. Historical research has shown that abnormal returns (ARs) are that point of an event study.
MacKinlay (1997) observes the importance of ARs around the initial announcement on the wealth effect of M&As. According to the efficient market hypothesis, any information is impounded in the stock prices. Therefore, ARs cannot be earned by an information set. Using α and β estimated before, both AR and CAR can be measured
8Estimates from ordinary least squares (OLS) with a market index tested with parametric statistical tests are well specified using non-normally distributed daily data and in the presence of non-synchronous trading. (see Brown and Warner’s 1985)
with the following formula:
ARjt = Rjt – αj - βjRmt (2) CARj(T1-T2)=ΣARjt (3)
The length of estimation period for α and β is 135 days from 25 days prior to event day to 160 days prior to event day. This period of 135 days is sufficiently long enough for model coefficients estimation (Brown & Warner, 1985). CARj(T1-T2) is calculated as the cumulative return from day T1 to day T2. I have calculated different estimation event windows CAR(-1,1), CAR(-2,2), CAR(-10,10), CAR(-20,20) and CAR(-40,40) to investigate the short-term effect of an M&A event on the acquirer’s shareholder wealth.
To investigate the acquirer’s shareholder wealth effect of acquisition with different characteristics, I perform a multivariate analysis:
ARj = α + β1Cashj + β2Equityj + β3Log(deal sizej) + β4Log(company sizej) + β5ROAj
+ β6ROEj + β7Miningj + β8Electricityj + β9Real estatej + β10Food producerj +
β11Civil law systemj + β12Common law systemj +β13Time2007-2008j + β14Time2009-2011j + εj
(4)
CARj(T1,T2) =α + β1Cashj + β2Equityj + β3Log(deal sizej) + β4Log(company sizej) + β5ROAj + β6ROEj + β7Miningj + β8Electricityj + β9Real estatej + β10Food producerj + β11Civil law systemj +β12Common law systemj + β13Time2007-2008j + β14Time2009-2011j + εj
(5)
Table 1: variable definition: this table illustrates the detail of each coefficient in multi-variable analysis
Variable type/name Description Data source
α Intercept
independent variable
AR Abnormal return Datastream
CAR Cumulative abnormal return Datastream
Variable type: continuous
Company size Acquirer's market capitalization one year before the bid's announcement(LN) Orbis
Deal value Bid's transaction value in millions dollar Zephyr
ROA Return on asset Orbis
ROE Return on equity Orbis
Variable type: dummy
Cash Dummy = 1 when it is considered as 100% cash Zephyr
Equity Dummy = 1 when it is considered as 100% stock exchange Zephyr
Mixed Dummy = 1 when it is considered as mixture of cash, stock, and other payment Zephyr
Mining sector Dummy = 1 when the company is in a mining sector Zephyr
Electricity sector Dummy = 1 when the company is in a electricity sector Zephyr
Real estate Dummy = 1 when the company is in a real estate sector Zephyr
Food producer Dummy = 1 when the company is in a food producer sector Zephyr
Civil law system Dummy = 1 when the company is in civil law country Zephyr
Common law system Dummy = 1 when the company is in a common law country Zephyr
Pluralistic systems Dummy = 1 when the company is in both civil law and common law system Zephyr
Time dummy(2004-2006) Dummy = 1 when the announcement happen between 2004 and 2006 Zephyr
Time dummy(2007-2008) Dummy = 1 when the announcement happen between 2007 and 2008 Zephyr
Time dummy(2009-2011) Dummy = 1 when the announcement happen between 2009 and 2011 Zephyr
3.2 Hypothesis development
Historical empirical evidences show that abnormal return is higher in cash financed deals than that in stock financed deals ( Servas 1991; Sudarsanam & Mahate 2003).
An equity payment is favored by acquirers when their own firm’s shares are overvalued or the target firm’s value is hard to predict. Thus, the announcement of acquisition financed by equity can be seen as a value-destroying process to the acquirer’s shareholder wealth (Myers & Majluf, 1984). Cash, conversely, generates positive benefits to shareholder wealth (Goergen & Renneboog , 2004 ; Martynova &
Renneboog, 2006). However, Myers (1977) argues that a firm with better future investment opportunities will choose to issue less debt to preserve the cash flow. In an emerging market, companies with more investment opportunities may favor shares as payment method to preserve the cash flow. There is also an alternative tax based hypothesis preferring stock offer due to the tax benefits compared with the immediate tax payment in the cash deal (Fuller et al., 2002). To investigate how the means of payment influence AR and CAR as market expectation on the announcement signal and whether new market knowledge is value-destroying in emerging markets, the following hypothesizes are formulated.
Hypothesis 1.1: Market will be more (less) likely to respond positively to stock financed deals than cash financed deals at the initial announcement.
Hypothesis 1.2: Market will be more (less) likely to respond positively to stock financed deals than cash financed deals around the initial announcement in a short period.
Moeller and Schlingemann (2005) concludes that a country with weak legal and institutional environment who have more asymmetric information and agency problems may increase the premium paid because of the concentrated ownership structures of target firms in these countries. However, the acquirer’s firm can also benefit from this by making the target firm accepting a lower premium to compensate for the information problems during the deal process due to a weak legal protection.
in a weak legal system in the period 1990-2003. Isabel et al., 2011 find that the stronger the legal environment of the acquiring firm country, this will generate more positive effect on the shareholder’s valuation in the acquirer’s company. Most of the empirical studies are focused on how legal system act on the cross-border acquisition process. I believe that there is less study on different characteristic of M&A in different legal system in a political perspective. Common law use social control strategies to support private market outcomes, whereas civil law is concerned with state-desired allocations. State-desired allocation may arise more government intervention in taxation, legal regulation and government investment. This can sometimes help the acquirer retain the benefits of acquiring the target company and can also include more moral hazard agency cost to build connection with the policy maker. Hypothesis 2 is then formulated.
Hypothesis 2: Civil law system imposes a positive (negative) effect on the bidder’s shareholder wealth than common law system does.
4 DATA DESCRIPTION
The data of M&A deals in five large emerging countries were extracted from ZEPHYR - Thomson DataStream - ORBIS. ZYPHYR provides entire look of merger and acquisition deals: acquirer name, announcement date, target name, deal value, deal status (completed, announced), acquirer country, target country, deal method of payment, deal type (acquisition). Thomson DataStream offers access to comprehensive time series database with 175 countries and 60 global markets in up to 50 years and country historical market return and acquirer’s daily stock price are available in it. Orbis included both M&A deals in ZEPHYR and company report in history with BvDnumber. I apply same filters to the primary M&A deal sample of five emerging countries (China, India, Brazil, South Africa, Singapore) from January 1, 2004 to December 31, 2011: (1) The deal is completed. (2) The deal type must be acquisition. (3) Deal value and means of payment must be available. (4) The
on one of five large emerging countries. (6) The minimum percentage of acquired stake is 50%. (7) The acquirer must be active and its daily stock price must be available in Thomsen DataStream. (8) The basic report of acquirer containing total assets, ROA and ROE must be available in Orbis. Campbell et al., 1997 conclude that the appropriate estimation window should be arranged from 120 to 210 days before the initial announcement date. I select an estimation window of 151 (-160, -10) trading days. After applying the filters to the original M&A deals, my sample includes 374 deals.
Panel A of Table 2 illustrates the distribution of M&A deals in five large emerging countries by different years. The sample includes 374 acquisitions. From 2004 to 2008, the distribution shows an increase trend and number of deals peak in 2008.
Maybe because the world financial crisis in most developed countries provide a chance for development in emerging markets. After 2009’s large drop, M&A transaction deals peak again in 2010 but instantly decease to 22 in 2011. The acquisition deals 2007 have both the highest total value of deals and average value of deals but the acquirers in these deals have the lowest average return on asset and average return on equity among 8 years.
Panel B of Table 2 shows the distribution of acquisitions in indifferent countries.
Obviously, China has both highest number of deals and largest value of deals.
Although Singapore hold smallest number of M&A deals, its average deal value and acquirer’s return on equity are highest. From the geographical perspective, most deals in this sample are concentrated in Asian countries, approximately 80%.
Panel C indicates the deal distribution in four top industries. Compared with other industries, mining sector obtains four highest statistic numbers: highest total value, most transactions, highest acquirer return on assets and highest acquirer’s return on equity. In general, the resource and energy sector shows a high level of transaction
than other sectors. An interesting sigh is that the total value of four top industries with 35.01% weights in number of deals is weighted 46.88% in total transaction value of the whole sample.
Panel D of Table 2 categorizes the sample data sets according to its nature of deal transactions. The surprising thing happen on cross-border deals with 25.13% deals but 45% of transaction value, nearly half. The financial sector also has double size of transaction value frequency of number of transaction frequency.
Figure 1, Figure 2 and Figure 3 illustrate the descriptive statistic in a more evocative way. Figure 1 depicts a whole sight of industry in thirty-eight sectors. The industry can be categorized into three levels: 0-10, 10-20, 20-35. Most industries fostered in the ―0-10‖ level, about 24 sectors, mainly consuming goods and services industry.
Seven sectors stay in the ―10-20‖ level, mainly some manufacture and financial sectors. Food producer, mining, electricity, real estate investment and software computer services lead in the highest level ―20-35‖. Figure 2 shows the movement of number of M&A deals by years. As can be seen from this figure, the increase trend is clear from 2004 to 2008. Start from 2009, emerging market experiences large fluctuation with a small downside in 2009, a rebound in 2010 and a sharp downside in 2011 as European sovereign-debt crisis happened. Figure 3 categorizes the five large emerging countries based on deal numbers. China takes the lead in race. China government who are eager to enter established markets and grab a share of economic power helps drives most of M&A deals by making its stated-owned companies invest over $ 200 billion per year to expect a higher return of the organization. It is clearly observed that Asian countries lead the M&As in the world, 77 percent of the whole sample, and present a potential threat to companies in developed countries.
Table 2 Descriptive Statistics for five large emerging countries in M&A deals
The sample consists of 374 completed acquisitions in five large emerging countries during the 2004-2011 periods. Data were extracted from ZYPHER.
Panel A: Distribution by year
YEAR NO. of Transactions Total Value ($ mil) Avg. Value ($ mil) Avg.Acquirer's ROA Avg. Acquirer's ROE
2004 35 953.21 27.23 5.31% 13.45%
2005 29 308.71 10.65 6.28% 13.96%
2006 46 860.77 18.71 6.03% 15.04%
2007 57 2681.02 47.03 3.13% 6.03%
2008 67 1824.88 27.24 5.39% 13.92%
2009 47 998.25 21.24 4.35% 10.49%
2010 71 1872.53 26.37 4.96% 10.78%
2011 22 431.78 19.63 6.44% 14.33%
Total 374 9931.15 26.55 5.04% 11.46%
Panel B: Distribution by country
Country NO. of Transactions Total Value ($ mil) Avg. Value ($ mil) Avg.Acquirer's ROA Avg. Acquirer's ROE
China 164 3283.93 20.02 4.66% 12.09%
India 94 1870.76 19.91 6.41% 11.58%
Brazil 47 2287.37 48.67 4.34% 9.71%
South Africa 40 865.31 21.63 5.64% 3.25%
Singapore 29 1623.77 55.99 2.99% 21.64%
Total 374 9931.15 26.55 5.04% 11.46%
Panel C: Distribution by Top Sector
Industry name NO. of Transactions Total Value ($ mil) Avg. Value ($ mil) Avg.Acquirer's ROA Avg. Acquirer's ROE
Electricity 25 1492.68 59.71 1.39% 5.56%
Food producer 31 486.58 15.69 3.84% 8.98%
Mining 46 2255.66 49.04 7.36% 14.58%
Real estate 29 421.95 14.55 3.54% -3.79%
Total 131 4656.87 34.75 4.03% 6.33%
Panel D: Frequency Distribution
NO. of Transactions Frequency % % of Total value
Cross-border Yes 94 25.13 45
No 280 74.87 55
Payment Cash only 175 46.79 36.59
mixed 113 30.22 41.83
Share only 86 22.99 21.57
Financial sector Yes 29 7.75 13.09
No 345 92.25 86.91
Top four sector Electricity 25 6.68 15.03
Food producer 31 8.29 4.89
Mining 46 12.29 22.71
Real estate 29 7.75 4.25
Figure 1: The sample industry distribution in thirty-eight different sectors
0 5 10 15 20 25 30 35
Figure 2: Number of acquisitions over 2004-2011
Figure 3: Number of acquisitions in five leading emerging markets
0 10 20 30 40 50 60 70 80
2004 2005 2006 2007 2008 2009 2010 2011
deals number
0 20 40 60 80 100 120 140 160 180
China India Brazil South Africa Singapore
5 EMPIRICAL RESULTS
Using multivariate analysis approach, I test both abnormal return at initial announcement and accumulated abnormal return around the announcement as independent variable to show the short-term influence of an acquiring process and market reaction.
5.1 Multi-Variable regression of Abnormal Returns
Model 1 includes only Cash and Equity dummy. Model 2 also includes four top industry sector dummy: Mining sector dummy, electricity sector dummy, food producer sector dummy and real estate sector dummy. Model 3 adds two legal systems dummy: Civil law system dummy, Common law system dummy. Model 4 consist of time dummy. Model 5 contains all the dummies included before.
Table 3 of AR multi-factor regression indicates that stock financed deal is an important indicator of abnormal return on initial announcement. I find that in the emerging five large countries, stock financed deals have significant negative effects on abnormal return in model (3), (4) and (5). Compared to equity dummy, cash dummy does not show any significant results.
I also investigate the impact of the following acquirer’s characteristic: Company size (total assets), acquirer’s return on assets and acquirer’s return on equity. Company size shows a statistically negative effect on the acquirer’s abnormal return on the initial announcement date. ROA also affect the acquirer’s abnormal return negatively in statistically significant manner. However, this may attribute to the correlation relationship between ROA and ROE.
I also include some legal system dummy and time dummy but these dummies do not indicate any significant results. In all four top industries, market respond positively to
to other three factors due to the probability of horizontal concentration which can boost the production efficiency, work as an expansion strategy and increase the advantage over other local competitors.
5.2 Multi-Variable Tests of Cumulative Abnormal Returns (-2, 2)
Table 3 also depicts the results of OLS regression of cumulative abnormal return over a three days event of five large emerging countries during 2004-2011 periods.
Compared to the results of AR regression, the OLS regression of cumulative abnormal return has a completely contradicted result in means of payment. It shows that market react very positively to the share financed deals with a critical value of average 0.03 at a 1% confidence level. This confirms my hypothesis. Although share financed deals will transfer value destroying information to the shareholder, this effect may be covered by other positive effects in the emerging market, like the tax reduction, synergy gains, government help and risk sharing (diversification benefits). Cash financed deals also show some positive figure in model (2), (5) and (6), critical value of 0.015 at a 10% confidence level, not as strong as that of equity.
We also find significant effects of company size on cumulative abnormal return. It means that larger company may comprise information problem and high probability of overvalued in an acquisition deal process. ROA and ROE do not indicate any statistically significant number in cumulative abnormal return regression which means that the characteristic like acquirer’s return on asset or equity do not matter at all to shareholder’s wealth.
The common legal system and civil legal system affect the wealth of acquirer’s shareholder wealth in different ways. Civil law system has a positively effect on the cumulative abnormal return with a critical value of 0.017 at a 5% confidence level while common law system shows a negative critical value of -0.014 at a 10%
significant effects. This indicates that the legal origin effect is not strong enough to affect acquirer’s shareholder wealth. In addition to the multi-factor regression of CAR (-2, 2), I also regress other event window CAR (-10, 10) and CAR (-40, 40). You can see it in appendix A.
Table 3: Determinants of Short-Term Wealth Effects for Acquiring Firms9
AR(country) CAR(-2,2)
Dependent
Variable (1) (2) (3) (4) (5) (1) (2) (3) (4) (5) (6)
Constant 0.032* 0.036** 0.025 0.035** 0.034* 0.025 0.0248 0.023 0.036 0.021 0.023
(1.762) (1.986) (1.332) (1.911) (1.741) (0.494) (0.658) (0.637) (0.966) (0.580) (0.600)
Cash 0.0003 0.0003 0.0004 0.00001 -3.25E-05 0.014 0.015* 0.013 0.014 0.015* 0.014*
(0.088) (0.074) (0.100) (0.002) (-0.007) (0.111) (1.656) (1.543) (1.565) (1.662) (1.641)
Equity -0.008 -0.007 -0.009* -0.008* -0.010* 0.027*** 0.029*** 0.031*** 0.032*** 0.028*** 0.033***
(-1.531) (-1.439) (-1.807) (-1.645) (-1.826) (2.579) (2.691) (2.936) (2.934) (2.646) (3.031)
Deal Value 0.001 0.0006 0.001 0.001 0.0008 0.004 0.004 0.004 0.003 0.003 0.003
(0.629) (0.395) (0.703) (0.695) (0.510) (1.252) (1.189) (1.211) (1.171) (1.142) (1.093)
Company Size -0.002** -0.002** -0.002** -0.002** -0.002** -0.004** -0.004** -0.005** -0.004** -0.004** -0.005**
(-1.997) (-2.077) (-1.950) (-2.039) (-2.090) (-2.056) (-2.038 (-2.268) (-2.174) (-2.036) (-2.210)
ROA -0.001*** -0.001*** -0.001*** -0.001*** -0.001*** -0.0009 -0.0008 -0.0008 -0.0009 -0.0009 -0.0006
(-3.060) (-2.851) (-3.010) (-3.085) (-2.835) (-1.338) (-1.070) (-1.116) (-1.273) (-1.263) (-0.818)
ROE 0.00007 0.00006 0.00006 0.00007 0.00005 -0.0001 -0.0001 -0.0001 -0.0001 -0.0001 -0.0001
(0.946) (0.780) (0.820) (0.918) (0.656) (-0.819) (-0.927) (-0.958) (-0.775) (-0.808) (-1.028)
Mining sector 0.005 0.006 -0.003 -0.006
(0.895) (1.065) (-0.281) (-0.521)
Electricity sector 0.012* 0.0145* 0.015 0.011
(1.658) (1.840) (0.966) (0.709)
Real Estate sector -0.006 -0.005 -0.005 -0.005
(-0.877) (-0.721) (-0.392) (-0.391)
Food producer 0.0009 0.001 0.009 0.010
(0.136) (0.200) (0.684) (0.763)
Civil law 0.004 0.003 0.017** 0.0139
(0.633) (0.572) (2.170) (1.035)
Common Law 0.008 0.008 -0.014* -0.003
(1.275) (1.199) (-1.744) (-0.261)
Time
dummy(07-08) -0.002 -0.003 0.009 0.006
(-0.613) (-0.617) (0.920) (0.682)
Time
dummy(09-11) -0.005 -0.006 0.008 0.002
(-1.265) (-1.319) (0.892) (0.222)
Observation 374 374 374 374 374 374 374 374 374 374 374
R-squared 0.041789 0.053711 0.046949 0.045996 0.064161 0.044773 0.049344 0.056909 0.052648 0.047545 0.062283 Adjusted-squared 0.026123 0.027643 0.026061 0.025086 0.027666 0.029156 0.023155 0.038871 0.034529 0.026669 0.025715 Prob(F-statistic) 0.015155 0.026891 0.023631 0.026875 0.043335 0.00965 0.046078 0.002988 0.005725 0.021795 0.053057
Note: * Indicates statistical significance at 10% level; ** Indicates statistical significance at 5% level; *** Indicates statistical significance at 1% level.
9The table shows the results of OLS (ordinary least squares) using the equation (4) and (5) over the 374 samples of acquirer’s AR and CAR (-2,
5.3 Robustness Test.
I also perform a significance test (t-statistic test) and mean difference test as robustness tests to check my principle findings. My robust finding is that stock financed deals impose more positive effect on acquirer’s shareholder wealth than cash financed deals do, while the results on legal origin are not robust.
Table 4, Panel A presents the results of acquirer’s average cumulative abnormal return calculated by market model over different event windows (t-1, 1, t-2, 2, t-10, 10, t-20, 20, t-40, 40). The short-term results of average cumulative abnormal returns are positive and significant, indicating that the acquisitions are favored by shareholder around the initial announcement date in a short term. Some characteristics of emerging market may help acquirers generate positive cumulative abnormal return:
inadequate market data, poor visibility on the regulatory environment, lack of information on sales channels, difficulty in finding right partners and cultural differences.
Panel B presents the results of CAR for method of payment and makes mean difference test between the two methods of payment in emerging countries. Cash financed deals generate significantly positive CAR in shorter period around the initial announcement at a 10% significant level and cannot generate any significant results in a longer period, which means that cash may be favored in the shorter period. Compare to the cash financed deals, stock financed deals present more positive and stronger CAR. The significantly negative difference between two methods also confirms this.
The main reason why stock financed deals are more favored in emerging countries may be that debt funding market is underdeveloped and share is a better choice for those financial constraint bidders to expand their business. Stock can also help both the target and the bidder share higher risk in stock market. Moreover, there may be some enthusiastic mode of the whole market due to the high growth opportunities and large synergy gains.
